Perhaps it’s because of his long-held view that bond yields will remain anchored – and might even enter (or reenter) negative territory in the near future – as the global economy slumps into another uncomfortable slowdown – but the financial press has been paying quite a bit of attention to Societe General global strategist Albert Edward. Barron’s back in April published a must-read interview with Edwards, in which he touched on his infamous “Ice Age” thesis, as well as the looming global recession. And this week, the Financial Times is back with its own piece on Edwards that’s pegged to the fact that Edwards’ former nemesis, Malaysian Prime Minister Mahathir Mohamad, has returned to power.
Edwards – who was then employed as a strategist at Kleinwort Benson Securities – made a name for himself back in the 1990s when he was writing (correctly, as it turned out) about some of the issues that led to the 1997 Asian financial crisis. The strategist, who moved to French bank Societe Generale just over 10 years ago, has over the last two decades earned a reputation as perhaps the best-known permabear on Wall Street.
The year was 1995 and, for market strategist Albert Edwards, a nasty piece of feedback had just arrived from the Far East. A one-page fax to Mr Edwards from a client of his then employer, Kleinwort Benson Securities, tore into a piece of his analysis which had suggested that economies round the Pacific Rim might be over-heating.
The client was having none of it: “Your understanding of this part of the world ranks on a par with Noddy and Big Ears’s comprehension of sub-atomic physics,” the client wrote.
And so was born in the strategist’s mind the idea of “Noddynomics” – an insult that Mr Edwards was soon to hurl in the direction of the then Malaysian prime minister, Mahathir Mohamad, in one of his regular strategy notes. Kleinwort Benson was not very popular in the region for some time.
Edwards readily admits that investors who followed his predictions to the letter would’ve lost money doing so (particularly since the dawn of QE), Edwards is refusing to give up on his long-term bearish view. Back in February, Edwards joined the ranks of US bond bears, with the caveat that his view was an explicitly short-term thesis (“I repeat my forecast that US 10y yields will fall below zero”).
Despite his on-paper record, Edwards has proved himself to be one of the Street’s more enduring strategists for his commitment to his contrarian ideas.
Mr Edwards’ durability has been evident in another form: in June each year winners are announced for the annual Extel Survey of analyst research. And every year, for the past 15 on the trot, this particular strategist has come top of the Global Strategy category. It is an extraordinary record, not least because, by his own words, Mr Edwards’ predictions have proved somewhat wrong for some time now.
Mr Edwards himself puts this down, at least partly, to the fact that he is ready to make fun of himself. “The Weekly note is short. It’s entertaining. And you’ve got to remember there’s so much bullish stuff out there,” he says. “Across the market people feel comfortable when everyone’s being bullish. So there’s room for a maverick. There’s room for the long view.”
And while the recovery wasn’t kind to devoted believers in Edwards’ “Ice Age” thesis (since the start of the year, equities have largely remained near their all-time highs, even during periods of intense market turbulence), at least one of his predictions has been proven correct:
In the years since, following the dotcom crash and then the financial crisis a decade ago, one side of the thesis has proved correct, with sovereign yields moving into negative territory across developed markets. But the secular derating of equities predicted by Mr Edwards has manifestly failed to happen.
But as stocks failed to rally during the Q1 earnings season and the correlation between climbing yields and a rising dollar reemerged, strategists at Morgan Stanley and elsewhere have reaffirmed their own long-term bullish views on volatility.
So while Morgan Stanley’s quants view near-term volatility pricing as roughly fair from a dynamic hedging perspective, “if buying options to benefit from price movement they are a little rich – hence the view to overwrite or play the upside via call spreads.”
Longer-term, however, the bank remains bullish on volatility given the nearing turn of the cycle – but for directional users of options it is better to wait until there is a catalyst for a crack in earnings, which will drive a true break of the range.
As Edwards explains, QE might work in the short term, but ultimately, it fails to solve the underlying problem. Credit bubbles like the one that triggered the financial crisis remain intact until the Fed and its fellow central banks – fearing that the economies they supervise would be left vulnerable should another collapse occur – decide to hike interest rates until they unleash another catastrophic “credit event”.
In a summary of one of Edwards’ more recent strategy notes, we reminded readers how Fed tightening cycles have preceded nearly every financial crash of the twentieth century.
But as Edwards and ideological compatriots see things, that’s hardly the Fed’s only shortcoming. The rapid expansion in home valuations and wealth inequality has created a generation of people who feel economically left behind setting up lawmakers to capitalize on the growing antipathy toward central bankers when the next crash hits.
“QE might look good for a few years, but it makes the problem worse. With a normal cycle, with interest rates going up quickly, these companies would have gone out of business quicker.”
So when the next credit bubble bursts, when the next crisis arrives, politicians will be looking for someone to blame.
“Last time they were able to blame it on the bankers, people like Fred Goodwin. But the commercial banks won’t he holding all the toxic waste next time. Instead, the politicians will be looking to the central bankers. They will lose the confidence.”
According to a BIS report released late last year, roughly 10% of companies in emerging and developed economies have only survived because central banks have suppressed real interest rates. These “zombie” firms will be the first to be culled by the next recession because, quite simply, they are unable to survive without the flow of cheap financing that has kept them afloat over the past decade.
This trend, combined with the disturbing jump in small-business credit-card charge-off rates…
…Has prompted Edwards to declare that the second-longest US economic expansion in history is nearing a spectacular end. To put a spin on a popular defense of central bank intervention, while this isn’t the first time Edwards has made such a declaration, This Time It’s Different.
Earlier this month, Edwards shared a message with the Federal Reserve that he learned during a recent vacation – a two-week long commune with nature in Lake Tahoe and Yosemite.
It was significant that we didn’t see any bears at either venue despite doing a 7.30am, 13 mile valley floor hike! I’m sure the absence of fellow bears was a significant countertrend sign. I learned something else on my trip worth sharing. We took the Yosemite Tram tour of the valley floor and the ranger gave a very interesting talk about fire. Until 1970 Yosemite Parks was extinguishing regular small-scale fires to prevent property damage. The resultant rise in dense small tree growth meant that although fires were less frequent, they quickly got out of control. Since 1970 they have allowed more fires to burn, resulting in less damage.
So, when the next recession finally arrives, will central banks be able to salvage their already damaged credibility? Or will this next crash lead to a fundamental shift in the view that central banks can and should be independent?
“The Fed could well lose its independence. So, too, could the Bank of England. And in my view they should.”